Ask anyone in the retirement fund industry, “how much is enough,” and they’ll trot out the tried and tested “save 15% per annum for 35 years” solution.
Invest your savings in an appropriate retirement savings structure, they say, and compound interest will ensure you achieve the required replacement ratio upon retirement. The replacement ratio is the percentage of your final salary you can “buy” in the year immediately after retirement.
Current thinking — based on the assumption your household expenses decline during your golden years — is for a replacement ratio of between 70% and 75%. The 15% monthly retirement contribution requirement is easy to motivate for.
An individual who contributes 10% of their salary over 30 years will only achieve a replacement ratio of 39%. This improves to 52% over 35 years and 68% over 40 years. A 15% monthly retirement contribution delivers 58%, 78% and 103% over the same timeframes.
The above scenarios assume gross real investment returns of 5.8% per annum, minimum annual pension fund fees and R1.5 million of retirement capital to purchase R100 000 per annum in pension income. Local savers aren’t doing nearly enough to ensure a comfortable retirement.
“South Africa’s average net employee and employer retirement saving contribution is around 10% of salary,” says David Gluckman, head of Sanlam Employee Benefit’s umbrella fund business.
Employees should consider increasing their monthly retirement fund contribution to at least 15% of their salaries and maintaining this premium for as long as possible, ideally 35 to 40 years! Unfortunately, many of us defer retirement saving until it’s too late.
“While you’re concentrating on more immediate costs and waiting for the ‘right’ time to start saving, your retirement may be approaching much faster than you realise,” says Andrew Davison, Head of Institutional Asset Consulting at Acsis. Why aren’t we saving enough?
Behavioural finance studies single out short-term thinking among retirement savers as the main problem. We’re simply not geared to plan our financial needs 30 or more years into the future. According to Sanlam Employee Benefits, the dire situation in the retirement provisioning space can be blamed on apathy and lack of education.
The group’s 2010 annual survey of the South African retirement fund industry reveals that 32% of fund members have never reviewed their portfolio construction, 49% of respondents have no understanding of how market movements can affect their fund, and 43% are unaware of how their money is invested.
One of the biggest problems is that few people benefit from continuous employment spanning three or four decades. The upwardly mobile middle and upper income groups tend to hop from one job opportunity to the next. And they fail to preserve their pension fund payouts.
Statistics in this regard are frightening. “If you don’t preserve your benefits, when you leave a pension fund, it’s the equivalent of your younger self taxing your older self,” says Old Mutual actuarial expert David Blecher. He uses a ‘real life’ scenario to qualify his statement.
Traditionally you would start saving at 25 years of age, stay with the same fund until the mandatory retirement age of 65 years, and retire with an income replacement ratio of between 75% and 85%. An individual who changes jobs three times in their working life — and withdraws 50% of his retirement benefit each time — will reach retirement with a replacement ratio of only 30%!
“The failure to preserve retirement benefits is the main reason people that were formally employed and had access to employer-sponsored pension funds end up with inadequate retirement capital,” says Pieter Koekemoer, head of personal investments at Coronation Fund Managers.
Davison agrees: “Preserving your retirement savings when you change jobs is just as important as starting to save from your first pay cheque!” We’re also living longer in retirement. This means the capital amount saved becomes inadequate to meet the increased living-standard needs.
“Longevity is one of the major financial risks facing pensioners, particularly women, many of whom live 25 to 35 years beyond age 65,” says Jeanette Marais, director of distribution and client services at Allan Gray.
According to the South African Annuitant Standard Mortality Tables, 51% of female pensioners retiring at age 65 this year will live more than 20 years after retirement. 18% will live for more than 30 years and 9% for more than 35 years. Changes in the way we save for retirement have also contributed to the growing savings shortfall.
Over the past decade, the retirement savings environment has morphed from a defined benefit environment — where the employer “guaranteed” a predetermined pension — to defined contribution — where the employee accepts all the risk.
In a defined contribution environment, your final pension hinges on the performance of the underlying assets in your pension fund. The 2008/9 recession had a major impact on retirement fund-values.
Gross investment returns of South African employer-based funds were decimated in 2008, falling to 6.7%. Although returns improved markedly in 2009, this did little to console the retirees who exited their retirement vehicles at the heart of the recession. Today’s obsession with return highlights another stumbling block for retirement savers.
Martin Poole, acsis Institutional Asset Consultant, says the incessant comparison of asset managers and portfolios is particularly damaging over the long-term. “History has shown that switching your investments for the wrong reason (such as poor market conditions) is the greatest destroyer of value,” he says.
What should you be doing to make sure you stash away enough of a retirement nest egg? Should you rely on your pension fund only?
Gluckman says the average pension fund will not deliver sufficient capital to maintain living standards after retirement, even if fund management costs are relatively low. The situation becomes progressively worse for members of pension funds with higher costs structures.
Gluckman believes the most cost- and tax-efficient option is to increase pension-fund contributions towards the maximum tax-deductible limits (7.5% employee contribution and 20% employer contribution in a pension fund) before considering other forms of savings. Savers, particularly those who get a late start, can use supplementary savings vehicles such as unit trusts, direct equity investments or fixed property.
“If you go outside the retirement space, your best plan of attack is to acquire growth assets, preferably in the equity or property line,” says Koekemoer. Equities and property offer the most consistent real returns over periods spanning 20 years and longer.
His solution — purchase a multi-asset unit trust with a bias to growth assets. Modern financial planning thinking requires the “saving” process to continue into retirement too. Unfortunately retirees are investing in conservative portfolios consisting primarily of cash and bonds.
“By investing in conservative portfolios, retirees struggle to generate enough capital to last through retirement,” says Marais. A retirement portfolio should be invested in a variety of assets in percentages appropriate for prevailing market conditions.
“We see shocking statistics of how many people cannot afford to retire comfortably,” concludes Davison. The only hope for these individuals is to continue working, rely on the government old-age grant, or seek financial assistance from their families.
“Starting to save early and always preserving when you change jobs are good decisions that will make a huge difference to your quality of life in retirement,” he says.